How profitable is Options trading?
Trading represents an integral part of the stock markets. Whether you deal in specific stocks, Futures, or indulge in Option Trading, the main goal of any trader is to make money.
However, making regular profits is not a piece of cake in the stock markets. There are multiple risks involved when it comes to trading stocks or derivatives. Hence, you should first educate yourself on the various aspects of trading before you jump into the markets to make a quick buck.
Different kinds of trading techniques
First, let’s look at the types of trading techniques that you can follow to trade in the stock markets.
As the name ‘Intraday’ suggests, all the trades executed under this technique are supposed to be completed within the same day. In an intraday trade, you can create multiple positions in an asset, but it is essential to close all of them before the end of the trading session. Intraday traders typically take small targets against small stop losses. Scalping is another intraday technique where the trader takes multiple quick trades in a stock or option to gain from the intraday volatility. Regardless of the trading strategy, all intraday positions should be closed within the same day, or else it would be called a swing trade.
Unlike the intraday form of trading where it was necessary to square off all your positions by the end of the day, Swing trading is different. While implementing this technique, a position might be open for multiple days or weeks. In a swing trade, the trader aims for a larger target hence the time frame of the trade is longer. As the time frame in swing trading is longer, the overall risk and volatility are reduced.
Positional trading is the longest and the least risky of the three as the holding period in this ranges from multiple weeks, months, or maybe years. Therefore, positional trades are executed on the basis of economic factors, long-term trends, etc. Here the intraday volatility does not cause any problem as the trades usually follow a long-term chart.
Using Options in trading
Options are a great tool to trade the markets. These have multiple applications in the stock market, be it for speculation, hedging or arbitrage. Options contracts are commonly used by skilled traders and investors to generate some additional income. As options are leveraged products, the risk involved is high. But to compensate for the high risk, these offer great rewards if your view on the underlying goes right. Therefore, Options are riskier, but you can implement numerous strategies to minimize the risk and maximize the reward.
Example of using options
Let’s consider an example to understand how Options can be used to generate profits, even in a downwards market.
For example, if you anticipate that the price of TCS that is trading at Rs 3500 currently, will fall below Rs 3400 in the upcoming month. You can sell the TCS 3500 CE (Call Option) at Rs 110. Therefore, if the underlying (TCS in this case) closes below the price of Rs 3400, you will gain a total of 110 x 150 = Rs 16,500/- per lot.
In the same way, if you have limited capital, you can still profit from the downward movement in a stock. For this, you can buy a PUT Option and benefit from the increase in the premiums of the PUT option when the price of the underlying declines.
Similarly, you can also implement Option spread strategies where you can hedge your positions by buying or selling another options contract at a different strike price.
How profitable is Options trading when compared to Equity trading?
Comparing equity trading to options trading is not an apple to apple comparison. But let’s try to figure out which one is better of the two.
When it comes to ‘Equity Trading’, you will have to be more accurate in terms of predicting the price movement. As you will only make money while trading in equity when you get the underlying direction correct. But when it comes to a sideways market, it is not easy to make money by trading stocks intraday.
Now, this is where ‘Options’ come into the picture. Derivative instruments, especially Options, are an effective tool to earn money in any market situation. Options give you the ability to make money in an upwards, downwards, and even a sideways market.
However, everything is not a rosy picture when it comes to options. Naked Option selling is extremely risky as it involves unlimited risks. Therefore, you should prefer using hedged strategies in Options and Futures to limit the downside risks.
Now to answer the question, Options trading can be extremely profitable. Provided you follow proper risk management and use hedged strategies. However, no definitive formula provides the probability of making money in options.
Options trading is altogether a different ballgame that requires much higher skills and expertise when compared to equity trading. Therefore, ultimately, it all boils down to your skills.
If you know the ins and out of Futures & Options then these can be an excellent tool for trading and generating additional returns. Limit the downside in case of any adverse market conditions.